Your Bitcoin Questions Answered

You've probably heard a lot about Bitcoin lately. The digital currency's price rose astronomically in 2017, going from less than $1,000 in March to a peak of more than $19,000 in mid-December. Other so-called "cryptocurrencies" based on Bitcoin have had similarly shaped trajectories.

Credit: ShutterstockMeanwhile, the technology behind Bitcoin, known as blockchain, has become the financial and tech industries' new buzzword. Companies are rushing to adapt the technology's seemingly magical powers to every possible application, with investors rushing to get in on the Next Big Thing. (An iced-tea company tripled its stock price after it added "blockchain" to its name.)

Despite all this hype, few people really understand what Bitcoin is or how it works. We're here to fix that.

However, we can't tell you whether to invest in Bitcoin, or in any other cryptocurrency. For that answer, consult your financial adviser.

What is Bitcoin?

Bitcoin is a decentralized, digital-only currency. It has no central monetary authority. Instead, a peer-to-peer computer network keeps track of Bitcoin transactions and creates additional bitcoins through a process called "mining."

Bitcoin users and their transactions are pseudonymous; there are no international exchange rates to figure out, and there's no need for middlemen to collect fees.

Bitcoin was created in 2009, in the wake of the near-collapse of the global financial establishment and soon after an individual or group using the name "Satoshi Nakamoto" posted a paper online discussing the idea of a decentralized digital currency free from interference by governments and financial institutions. Nakamoto created the online bookkeeping system to record and track Bitcoin transactions and mined the first bitcoins.

The software to create, track, hold and exchange bitcoins is open-source, so it can be used for free.

What is the Bitcoin exchange rate?

When Bitcoin was first released in 2009, one bitcoin wasn't worth much. A single U.S. dollar could buy more than 1,300 bitcoins. As Bitcoin became more popular internationally, speculation caused the value of a single bitcoin to soar to $260 in early April 2013.

Several cyberattacks caused the value to plummet to about $50 later that month in a wave of panic selling. But in November 2013, the rate skyrocketed to about $1,200 due to Chinese speculation. At that point, the Chinese central bank took steps to prevent domestic trading in Bitcoin.

For most of 2015, Bitcoin traded between $200 and $400, but in mid-2016, the exchange rate began to move again, increasing rapidly over the following 18 months to peak at about $19,000 in mid-December 2017.

Credit: CoinbaseAs of this writing, in early February 2018, one bitcoin is worth about $7,000, quite a change from a few years ago and following a volatile ride in the previous few months. (To check on Bitcoin's price at any given time, click here.) Its fluctuations are due, in part, to its capped amount of 21 million individual bitcoins and to its perceived value on the market.

How do you buy bitcoins?

Anyone can buy bitcoins. You'll first need to set up a Bitcoin wallet, either on a computer you control or with an online Bitcoin service. Some of the most popular services are Coinbase (perhaps the best wallet for beginners), Mycelium and Electrum. You can also find Bitcoin wallet apps in the iTunes App Store or Google Play. Most of these services will walk you through the process of setting up your wallet.

Credit: GDAX.comThen you'll work through a broker to buy Bitcoin. Coinbase, again, is a good starting point for beginners, but other brokers include CEX, GDAX and Poloniex. You then use a credit card, debit card or bank transfer to make the purchase. However, many card issuers in the U.S. and U.K., including Bank of America, Lloyds, Citigroup, Halifax, JPMorgan Chase, Capital One, MBNA and Discover have said they will not authorize cryptocurrency purchases.

What is Bitcoin mining?

Bitcoins can be purchased using real money, but they can also be generated or "mined." Users generate bitcoins by having their computers solve difficult mathematical algorithms that help verify the creation of new bitcoins in the blockchain — the encrypted ledger that records and registers all Bitcoin activity — and the transfer of bitcoins between users. The algorithms become progressively more difficult over time.

Blockchain hosts keep track of all transactions and broadcast new transactions across the host network, incrementally adding to the blockchain. Computers that are participating in the network communicate and agree on updates to the blockchain.

About every 10 minutes, a blockchain host whose blockchain updates have been approved and packaged into a block earns 12.5 bitcoins. When Bitcoin first came into being, the reward was 50 bitcoins, but the reward amount halves with every 210,000 blocks registered, equivalent to about four years.

The total number of bitcoins that can ever be mined is 21 million. The cap prevents anyone from flooding the market and devaluing the bitcoins already in circulation. According to Blockchain.info, which provides real-time updates on bitcoins, at the beginning of 2018, there were just shy of 17 billion bitcoins in existence, or about 80 percent of the total number possible. The projected date by which all 21 million bitcoins will have been mined is 2040.

Bitcoin miners. Credit: Bitcoin.comMining Bitcoin can be lucrative, but it requires up-front investment in robust computer-processing hardware and is not easy. Gone are the days when you could use an old computer.

Some Bitcoin miners rig up chains of high-end graphics cards normally used for computer gaming, but perhaps the best current method is to use a Bitcoin-mining application-specific integrated circuit (ASIC), which is a generic term for a computer chip designed for a specific purpose. (The "system on a chip" in your smartphone is another type of ASIC.)

Each mining ASIC is measured by its power efficiency and price per computation. Mining ASICs can cost anywhere between $400 to a few thousand dollars per unit. Higher-end models will generate bitcoins more rapidly.

Energy usage has become a major issue in Bitcoin mining. According to the cryptocurrency website Digiconomist, the electricity used for the creation of one Bitcoin blockchain block could provide a day's worth of power for 11 average U.S. households.

Once you have the hardware to mine Bitcoin, it would probably be most efficient to join a Bitcoin mining pool, in which a group works together to solve a block. You can work alone, but it will take longer and be less rewarding. To be awarded bitcoins, miners must be able to verify 1MB of transactions and be the first to compute a 64-digit hexadecimal number. Working in a pool increases the possibilities of receiving an award, even if it is shared.

For beginners or those who see mining as a hobby, it may be more worthwhile to mine for other cryptocurrencies that have lower hardware requirements than those for mining Bitcoin. Mining lesser-known cryptocurrencies, which will be discussed later in this article, can earn you the equivalent of a couple of hundred dollars a month.

What can you buy with Bitcoin?

Because of the built-in pseudonymity, bitcoins are often used for illicit activity. However, many legitimate businesses, ranging from hotels to electronic stores, accept bitcoins. Here is a partial list of companies that accept Bitcoin as payment as of February 2018:

Dish Network

Expedia

Golden Gate Hotel & Casino (Las Vegas)

Newegg

OkCupid

Overstock

Reeds Jewelers

Reddit

Roadway Moving Company

Subway

Zynga

There is also speculation that Amazon may soon accept Bitcoin, but that's only a rumor for now.

Is using bitcoins legal?

Bitcoins aren't regulated by any government, which raises questions about their legality.

In the United States, use of Bitcoin is legal because it isn't a physical form of currency like the dollar. Were the currency to be given a physical form, like a silver dollar, the creators would be held guilty of "making, processing and selling" their own currency. Bitcoins are legal but regulated in Canada and Mexico, and legal in most of Europe as well as New Zealand and Australia.

Credit: ShutterstockIn China, it is legal for private citizens to hold Bitcoin, but since 2014, it has not been legal for financial firms to do so. Bitcoin exchanges continue to operate in China, although not at the volumes they did before 2014, and the Chinese domestic currency, the yuan or renminbi, can't be used to add or withdraw funds from a Bitcoin account. In early February 2018. China said it would block access to overseas Bitcoin exchanges from within the country.

Bitcoins are illegal in several countries, including Bangladesh, Bolivia, Ecuador, Kyrgyzstan and Nepal.

Is using Bitcoin anonymous?

Using Bitcoin is not 100 percent anonymous; rather, it is pseudonymous. Users can employ whatever names and handles they want. But because of the fixed and transparent nature of the blockchain accounting system, all transactions involving Bitcoin are public, and anyone can see how many bitcoins are in a given wallet.

Bitcoin "ATMs," which trade cash for bitcoins or vice versa, allow for additional anonymity. You could also use multiple wallets or mix Bitcoin services to obscure the digital paper trail, and there are other practices for hiding identity. But in the end, nothing is foolproof.

What is a blockchain?

The blockchain is the distributed digital ledger that documents all bitcoins and Bitcoin transactions, and is Bitcoin creator Satoshi Nakamoto's primary technological innovation. It is the only place where bitcoins "exist." Several times every hour, new batches of Bitcoin transactions and creations called "blocks" are registered and transmitted over the internet to all hosts of the Bitcoin blockchain.

Whenever a block is completed, it is added to the chain, creating a permanent and unalterable record. Each new block is cryptographically linked to the previous block, and changing any recorded block would create a mathematical ripple effect that would be immediately visible to all blockchain hosts. Because of this, the blockchain acts as its own ledger, similar to a bookkeeping ledger.

Because the blocks can't be altered in any way, users can validate cryptocurrency transactions without need of a third party or outside-storage source. The blockchain prevents a single unit of bitcoin from being used in two different transactions at the same time. It also allows users to remain relatively anonymous, although Bitcoin addresses are permanent.

Because it is decentralized and easily verifiable, blockchain technology can be used for other purposes. It could be used to share sensitive databases, such as gun registries or medical records, on a large scale. It could also provide a more secure way for traditional financial institutions to operate. Some blockchain advocates suggest that the technology could enable secure online voting and protect the copyrights of digital music or books.

What are Bitcoin wallets?

Bitcoin transactions are processed through a Bitcoin wallet, an application that users download and install on their computers or smartphones. A purchaser or seller is identified only by his or her digital wallet's "address," a unique string of letters and numbers with a "key" (another numeric string), which only the wallet holder has.

Wallets can be set up for free and with relative ease, meaning consumers can open and close wallets at will to maintain their anonymity. One person can have multiple wallets, and multiple individuals can control a single wallet.

There are several types of Bitcoin wallets to choose from, each with its own set of pros and cons. The options include:

Desktop wallets: Software is downloaded directly to the computer, giving users full control and responsibility.

Because the Bitcoin address is kept on the computer's storage drive, no one else has access to it. But the user must ensure that there is a backup of the drive and must have a security system installed to prevent theft of the Bitcoin data. If the desktop wallet is corrupted in some way, any Bitcoins stored there are deleted and irretrievable.

Desktop wallets come as either full-size clients or light clients. Full-size clients allow the user to host and read a copy of the entire Bitcoin blockchain, which is approximately 140GB today. Light clients simply provide Bitcoin storage and require external sources to read the blockchain.

Mobile wallets: These wallets are accessed through an app on your smartphone or tablet. They can be easy to use, offering touch-screen controls and the ability to scan QR-coded Bitcoin addresses, but mobile wallets can access only a small portion of the entire Bitcoin blockchain and so are considered light clients.

Online wallets:Web-based wallets allow you to manage bitcoins through your browser. These wallets are convenient because they can be accessed at any time, and anywhere. You can't accidentally delete them, and you don't have the responsibility of backing up your holdings. However, third parties usually manage online wallets, and this involves high levels of trust and means that you have to rely on someone else to handle the security. The companies that manage online wallets often also act as Bitcoin brokers, which make money by taking a cut of every transaction they manage.

Paper wallets: Bitcoin address keys and QR codes are printed on paper or some other medium. You don't have to worry about cyberattacks stealing the information, because nothing is stored digitally, but if the paper is lost or destroyed, access to the bitcoins is gone forever.

Hardware wallets: This kind of wallet is an external device specifically designed to hold and manage bitcoins. No transaction can take place unless the hardware wallet is connected to a computer or mobile device, and access to the bitcoins held within is often protected with a PIN code. Hardware wallets are considered the most secure type of Bitcoin wallets. The downside is that it is they're not free.

What is a Bitcoin address?

Your Bitcoin address works much like a bank account number. It is a unique combination of letters and numbers, of from 26 to 35 characters, that is used to send and receive bitcoins and is connected to your Bitcoin wallet. Most users have multiple addresses tied to a single pseudonym. The "key" to the Bitcoin address is cryptographically linked to the address, and only the holder of the address should have that key.

What are Bitcoin forks?

Because there are so many players involved in mining and using Bitcoin, there is some disagreement about common rules. This has led to forks: technical actions that have separated the blockchain into new paths.

Bitcoin has multiple forks. The two best-known are Bitcoin Cash and Bitcoin Gold.

Bitcoin Cash was introduced in the summer of 2017, when miners wanted to move bigger blocks of memory in the blockchain. While Bitcoin moves at 1MB per block, Bitcoin Cash moves at 8MB. This allows for an increase in the rate of transactions in the ledger The Bitcoin Gold fork occurred in the fall of 2017 and was meant to make it easier to mine money once again.

More than a dozen Bitcoin forks are planned for 2018, including Bitcoin Silver, Bitcoin Uranium and Bitcoin God.

What's the link between Bitcoin and crime?

Bitcoin is often the currency of choice in cybercrime transactions, including the selling of goods such as drugs, guns, child pornography, malware and phony antivirus software; the selling of services such as botnet rentals; and the payment of ransomware ransoms. Some experts believe the growth of Bitcoin and the parallel growth of ransomware are directly related.

There was ransomware and scareware before there was cryptocurrency, but when cybercriminals used more-traditional payment methods, or even PayPal, transactions could be traced to bank accounts. The introduction of Bitcoin made it more difficult follow the thread of payments back to real-life accounts.

Cybercriminals know that their targets are becoming savvier about ransomware and are taking steps to avoid paying the Bitcoin ransom to retrieve their data. Not surprisingly, criminals have discovered new ways to "earn" Bitcoin. They are now infecting websites and online ads with malware that turns the computers of visiting browsers into cryptocurrency-mining machines. Administrators of some websites are also doing this directly to create an additional revenue stream, and it's not clear whether it is illegal to do so without informing site visitors.

What's the deal with attacks on Bitcoin exchanges?

Criminals have set their sights on bitcoins and have attacked Bitcoin exchanges. One of the best-known attacks was the one on the Mt. Gox exchange, until then the world's largest Bitcoin exchange, in 2014.

The exchange suffered a series of DDoS attacks in February of that year that caused lags in trading and locked users out of their accounts. Shortly afterward, Mt. Gox discovered that thieves had stolen some $450 million in Bitcoin from the exchange.

Some of the money had been skimmed off over the previous three years; another chunk was stolen during the DDoS attacks. By the end of that month, the CEO had shut down the exchange site and declared bankruptcy.

Cyberattacks on Bitcoin exchanges are becoming more common, especially as the currency increases in value. Phishing attacks to steal user or administrator passwords are the most common attack vector, but cybercriminals are also going after mobile wallets and targeting weaknesses in the blockchain. Malware written for Windows and Mac also looks for and steals bitcoins from infected computers.

Because of the nature of the currency, once a bitcoin is stolen, it's nearly impossible to recover.

What other cryptocurrencies compete with Bitcoin?

Bitcoin is the best-known cryptocurrency, but it is not the only one. Here are other cryptocurrencies that have arisen in the wake of Bitcoin:

Ethereum is a software platform and programming language that runs on its own blockchain and is traded as a digital currency commodity. Ethereum is perhaps the most widely used non-Bitcoin-based cryptocurrency and has already spawned a rival fork called Ethereum Classic.

Litecoin is a peer-to-peer, open-source currency that is fully decentralized. Litecoin is mathematically very similar to Bitcoin but features faster transaction-confirmation times.

Zcash was developed by privacy-minded information-security experts. Zcash's encrypted payment transactions use a unique cryptographic method to verify validity.

Monero claims to be truly anonymous by hiding the addresses used in each transaction. As such, it has become a cryptocurrency of choice for criminal activity. Many cryptocurrency miners surreptitiously embedded into websites mine Monero.

Iota centers on communications and payments between Internet of Things devices.

Is Bitcoin a bubble?

Bitcoin may seem like a great investment opportunity right now, but is the bubble about to burst? Bitcoin proponents see it and other cryptocurrencies as the future of currency and trading, and point to the rise in public interest in Bitcoin and its acceptance by mainstream financial firms as evidence of Bitcoin's inevitability.

However, Bitcoin is still an unknown quantity. Its exchange rates are extremely volatile, and we don't know if a one-day drop will turn into a permanent crash. Based on the history of stocks and other commodities, a Bitcoin crash is likely. It's also likely that afterward, there will be more stability as the market corrects itself.

We're not here to tell you whether to invest in Bitcoin or any cryptocurrency. This piece is a guide to help you better understand Bitcoin, both its benefits and its risks.

Who is Bitcoin creator Satoshi Nakamoto?

Nakamoto might have been Hal Finney, a California computer scientist who was the first person to receive a Bitcoin payment from Nakamoto. Finney always denied that he was Nakamoto, and he died in 2014.

Another leading suspect is Nick Szabo, a computer specialist based in Washington state who worked on the theories of cryptocurrencies years before Bitcoin was unveiled. One analysis of Szabo's and Nakamoto's writing styles concluded they were "probably" the same individual, but Szabo has denied it.

In 2014, Newsweek magazine claimed that a Japanese-American computer specialist named Dorian Nakamoto was the Bitcoin creator. Dorian Nakamoto quickly denied it. In 2016, Australian entrepreneur Craig Wright announced that he was Satoshi Nakamoto. Several experts said Wright's cryptographic "proof" was unconvincing.

If Satoshi Nakamoto is a single individual, he or she is worth a fortune. Bitcoin addresses controlled by Satoshi Nakamoto hold nearly 1 million bitcoins, worth about $10 billion at current exchange rates.